Are Cracks Starting to Show in Foundation of Real Estate Stocks?

by Ethan Roberts | February 21, 2013 1:26 pm

In recent months, the real estate market has been on quite a tear. Nationwide home prices are up about 8% from a year ago, investors are out hunting in droves for what limited bargains remain and multiple offers are commonplace on properties of all price ranges.

In fact, a report released today shows U.S. re-sales edging higher by 0.4%[1] in January, leaving the supply of homes at its lowest level in 13 years. This was the second highest total since 2009, near the end of the home buyer’s Federal tax credit.

Real estate related stocks, such as the homebuilders, REITs and companies who benefit from a growth market have also been very strong this year. However, on Wall Street there is always an attitude of “what have you done for us lately?” And this week, when Toll Brothers (NYSE:TOL[2]) and Owens Corning (NYSE:OC[3]) — an Ohio-based company that manufactures basic housing materials such as insulation and roofing shingles — both turned in earnings reports that didn’t dazzle the analysts, their stocks were quickly punished

Heading into the report, Owens had climbed about 43% since mid-October. When it posted an EPS of 11 cents — 5 cents short of forecasts — the stock tumbled double-digits. And while Q4 quarter revenue of $1.16 billion was in line with expectations, it dropped 3% from a year ago.

Toll Brothers was also rocked when it failed to meet analyst expectations in its first quarter earnings report. Net income of $4.4 million, or 3 cents a share, did not satisfy a Wall Street crowd that was expecting 10 cents a share.

Even Lumber Liquidators (NYSE:LL[4]), which beat analyst expectations on both revenue and earnings per share this week, is off more than 8% today. Wall Street is obviously in an anxious mood right now, with an itchy trigger finger to sell off real estate related stocks for any reason.

Of course, it also didn’t help when the National Association of Home Builders announced surprising drop confidence level for the first time in many months, falling from 47% to 46%. And immediately on the heels of that story came word that January housing starts[5] were down 8.5%. These companies are dependent upon a good housing market for their share prices to flourish.

Today’s decent U.S. re-sales report has not done much to overcome the other negative news. Owens Corning is down another 4% today, while TOL is just over 1%, but the volume is not impressive.

The accompanying chart shows the devastating hit that TOL took on Wednesday, as it dropped over 9%. Look at the enormous bearish engulfing candlestick, as TOL fell below the 50-day moving average, effectively wiping out multiple weeks of gains.

Courtesy of stockcharts.com[6]

Despite the drop, I still believe that better days are ahead for Toll Brothers. It’s entirely possible that The Street overreacted, which is typical for overextended markets like this one. A year ago, TOL had a loss of $2.8 million — or 2 cents per share — so the earnings report actually showed substantial improvement year-over-year.

Longer term, TOL still has excellent prospects with its luxury condo market and apartment building projects. However, with the technical damage done this week, it is likely to see further downside and should be avoided at this point. An entry point around the 200-day moving average, currently at $31.63, is preferable, and is about 6% below the current price.

While it is not easy to go against the prevailing optimistic mood that has taken over the real estate market recently, a healthy dose of reality might be just what is needed right now. Take it from someone who has witnessed both the euphoric highs and disconsolate lows of the last 17 years.

In a recent InvestorPlace article[7], I laid out four reasons that home prices could stall in 2013: a rise in the number of listed properties, shadow inventory, weak job creation and appraisal problems. I also posed the question of whether reduced consumer expectations will negatively affect the real estate market and bring the recent gains to a halt.

This warning was echoed by Rick Judson, a homebuilder and NAHB chairman, who commented on the decline in the NAHB index, saying: “This is partly due to ongoing uncertainties about job growth and consumer access to mortgage credit.”

Throw in today’s rise in weekly jobless claims, along with the rise in core CPI and you have a recipe for an overheated real estate market sector to take a well-needed “pause that refreshes.”

For the moment, it might be a wise strategy to wait out the expected decline with fresh funds.

As of this writing, Ethan Roberts did not own a position in any of the aforementioned securities.